Post-briefing with regards to the Sabah Sales Tax (SST) issue, management affirms that the Group will continue opposing the Sabah state government against the imposition of the SST. This also after taking into consideration various legal opinions that are also against the paying of the tax. This unresolved dispute with the state may cloud the Group’s outlook nonetheless, potentially causing prolonged disruptions to operations in Sabah with issues involving manpower movement and/or shortages. This will limit its operational efficiency, which will eventually impact its output. Although the potential damage is difficult to gauge at this juncture, we err on the conservative in our oil production and sales projections, with a downward adjustment of ~10%. As such, our FY23/24 earnings forecasts are adjusted lower by 11.3% and 10.2% respectively, which lowers our valuation to RM1.20. Our TP is cut to RM0.96 however, as we impute a further 20% discount to account for current uncertainties which may result in unexpected disruptions to operations. The discount is also equivalent to 0.7x price-to-book value, most recently hit in March 2020. We retain our Neutral call pending resolution of this dispute.

• Sabah Sales Tax issue. The Sabah state government has issued a notice to Hibiscus that working permits for its North Sabah and Kinabalu fields will be cancelled on Oct 1, 2022, if payment of the taxes and penalties are not settled. To recap, Hibiscus has discontinued the payment of sales taxes after taking over the Kinabalu asset from Repsol, the latter making payments “under protest” since April 2020 however. The North Sabah asset has not been paying the SSTs to the state at all meanwhile. Hibiscus argues that it sold its crude oil at the Labuan Crude Oil Terminal (LCOT) facility which is outside the sovereignty and jurisdiction of the state of Sabah, thus, should not be paying the SST.

• Potential disruption to Sabah operations. Post-briefing, management affirms that the Group will continue opposing the Sabah state government against the imposition of the SST. This also after taking into consideration various legal opinions that are also against the paying of the tax. There is no specific timeline given though it is targeted to be resolved by 1st October. This unresolved dispute with the state may cloud the Group’s outlook nonetheless, potentially causing prolonged disruptions to operations in Sabah with issues involving manpower movement and/or shortages. Shut down in field operations is unlikely though these issues will limit its operational efficiency, which will eventually impact its output. Thus far, management confirms that it is already facing issues with the slower approval for working permits by the state authority.
• Earnings impact. Our base case scenario is that there will be a decline in production given the possible disruption. Although potential damage is difficult to gauge at this juncture, we err on the conservative in our oil production and sales projections with a downward adjustment of ~10%. As such, our FY23/24 earnings forecasts are adjusted lower by 11.3% and 10.2% respectively. Meanwhile, our worst-case scenario suggests that the Group pays the SST annually moving forward, with an estimated amount to be around RM46m per year, by assuming c. 300,000 and 350,000 bbls of oil to be sold per offtake for the North Sabah and Kinabalu fields respectively. Subsequently, this will affect our earnings forecast by -7.8% on average, with our DCF-based TP potentially cut to RM1.18. We are not imputing this in our projections yet however, pending outcome from the dispute. As for the stated amount of RM97.31m, comprising RM66m in sales tax and RM31.31m in penalties, management indicates that its auditor has agreed with the legal opinions and does not require a provision. Nevertheless, the decision was made before the notice issued by the Sabah government. Settlement of the arrears is not an issue given the Group’s cash holding of RM437.8m.

Source: PublicInvest Research - 21 Jul 2022